Profit Sharing Investment Research Articles

Tantangan Akuntansi Syariah dalam Pengelolaan Rekening Investasi Berbagi Keuntungan pada Bank Islam

Because interest-bearing deposits are not allowed by Islamic Sharia rules and principles, Islamic banks generally collect deposits in the form of profit-sharing investment accounts. These accounts differ from conventional deposits not only because of the profit-sharing nature of the returns they offer but also because the relationship between the customer and the bank is not a debt contract, so these deposits are not considered 'fixed capital.' (artinya, nasabah dapat menerima hasil negatif atau kerugian). This last characteristic poses serious regulatory issues in jurisdictions where bank deposits are legally required to have a definition of 'certain capital.' In general, the presence of such 'risk-bearing instruments' in the capital structure of Islamic banks complicates the assessment of their capital adequacy. Moreover, the fact that profit-sharing investment account holders are a type of equity investor without the governance rights held by creditors or shareholders poses a significant oversight problem. This article explains these issues in more detail and proposes a solution in the form of a structural distinction between Islamic banks in the narrow sense on one side, and entities managing profit-sharing investment accounts on the other.

Adoption patterns of profit-sharing based deposits: empirical evidence from a Muslim majority country

PurposeThis paper aims to examine the antecedents of adoption intention of profit-sharing investment deposits (PSID) among Moroccan customers.Design/methodology/approachApplying an extended version of diffusion of innovation (DOI) theory and using a non-probability sampling technique with convenience approach, a quantitative survey was developed and administered to 171 Islamic banking users. Structural equation modeling was then used to evaluate the significance of relationships between the various variables under study using SPSS 21.0 and AMOS 26.0 statistical packages.FindingsEmpirical findings of the structural analysis indicated a significant direct relationship between adoption intention and six out of seven variables: perceived relative advantage, perceived compatibility, perceived complexity, perceived risk, religiosity and social influence, all of which had a significant effect on Moroccan customers’ intention to invest their funds in profit-sharing based deposit instruments, whereas customer awareness exerted an insignificant positive effect.Research limitations/implicationsThe absence of a longitudinal study tracking the actual adoption behavior is the main limitation of this study. Furthermore, data were collected solely from Islamic banking users. Finally, despite being insightful, the empirical findings should be generalized with caution since the sample was purposely selected by the banks’ management.Practical implicationsThis study implied that participatory banks should pay substantial attention to risk perceptions, as PSID adoption intention is typically inhibited by high perceived risks associated with these products. Moreover, this study provides great indications to Moroccan regulators and policymakers on a number of issues related to this emerging business.Originality/valueTo the best of the authors’ knowledge, this paper represents the first attempt to confirm the effectiveness of the Rogers’ DOI in examining the intention to adopt a financial innovation in the Moroccan context. It is also the first of its kind to address customers’ apprehensions regarding profit-sharing investment products.

Bank social fund distribution and cost of profit-sharing investment account: evidence from Indonesia

Purpose - This study aims to prove the impact of the distribution of social funds (qardhul hasan-QH and zakah funds) on the cost of a Profit-Sharing Investment Account (PSIA) immediately and for a long period in Islamic banks.Method - The research is based on panel data from 11 Islamic commercial banks (IB) in Indonesia from 2009 to 2021. Data were analyzed using the generalized least squares (GLS) random-effects method with robust standard error.Result - This research proves that the distribution of social funds (the distribution of QH and zakah funds) has a positive economic impact in the short period but the distribution of social funds has a negative economic impact in the long period.Implication - This study contributes to bank directors in considering the social activities of banks funded by QH funds by considering the effectiveness of social fund distribution, hence having positive economic consequences for bank performance.Originality - This research contributes to the development of previous literature in two ways. First, we use CSR performance proxies that are different from previous studies, namely the distribution of QH and zakah funds. The distribution of these funds is a proof of the bank's legitimacy to care about social, economic, and environmental issues. Second, we use the cost of PSIA as an economic consequence of CSR performance.

The impact of displaced commercial risk on the performance of Islamic banks

Islamic banks are exposed to a particular risk that stems from one specific service that they offer: the collection and management of deposits in the form of unrestricted profit-sharing investment accounts. These accounts are the source of displaced commercial risk, which arises from assets managed on behalf of investment accountholders, effectively being transferred to the Islamic financial institution's own capital stock. This occurs because, when considered necessary, banks do not pay part or all of their due Mudharib shares, which would otherwise be paid to depositors, as a result of commercial pressure to increase returns. This study assesses whether this risk hinders the performance of Islamic banking institutions already struggling to compete for deposits in a system dominated by well-established conventional banks. Using the methodology developed by Beck and Katz (1995) to analyze data collected from Bahraini banks, the study demonstrates the existence of a negative and statistically significant relationship between DCR and the performance of Bahraini Islamic banks. This result suggests that increases in DCR are driven by dissatisfied profit-motivated depositors wishing to transfer their funds to more rewarding investments (either Islamic or conventional). Furthermore, an upsurge in this particular risk impels the bank to accumulate more investment reserves, which jeopardizes their profitability, especially when they are kept as idle cash or invested in illiquid assets. Therefore, our results provide regulators and decisionmakers in both Bahrain and other countries where Islamic and conventional financial institutions coexist with a better understanding of the unrestricted profit and loss sharing contracts of Islamic banks.

Determinants and consequences of maqashid sharia performance: evidence from Islamic banks in Indonesia and Malaysia

PurposeThis study aims to examine how sharia supervisory board (SSB) characteristics are determinants of the maqashid sharia performance (MSP) of Islamic banks (IBs) and how MSP has implications for profitability and for profit-sharing investment account holders (PSIAHs).Design/methodology/approachMSP is ascertained by semi-structured interviews. The SSB characteristics measured are size, cross-membership, education level, expertise, reputation, rotation and remuneration. Annual reports of Indonesian and Malaysian IBs from 2010 to 2018 are analysed using panel data regression.FindingsIn Indonesia, SSB education level attenuates MSP, while other characteristics have only minor influence. However, in Malaysia, SSB size, education and reputation reinforce MSP, while others are ineffective. MSP in both countries is pseudo-Islamic; so their customers ignore religiosity. However, MSP in Malaysia can improve profitability because sharia assurance is more transparent; meanwhile, MSP in Indonesia cannot improve profitability because sharia assurance is less transparent.Practical implicationsIn order for MSP to improve in Indonesia, the regulators need to increase SSB size, reduce cross-membership and arrange the format for sharia assurance in SSB reports, while IBs need to increase SSB education and expertise.Originality/valueMSP is constructed in accordance with legal and social requirements to achieve IBs’ Islamic, economic, social and ethical objectives. Resource dependence theory is used to evaluate SSB, while PSIAH and profitability are investigated to demonstrate the impact of MSP. Finally, comparing SSB capabilities in Indonesia and Malaysia could be beneficial to regulatory and IB policies.

Deposit withdrawal intentions of profit-sharing investment depositors: evidence from Morocco

PurposeThe purpose of this study is to examine the factors affecting deposit withdrawal intentions among Moroccan profit-sharing investment account holders.Design/methodology/approachApplying the push-pull-mooring (PPM) theory, a quantitative survey, based on insights brought to light by a previous qualitative study, was developed and administered to 166 depositors from five participatory banks at branches located in Morocco. Structural equation modeling was then used to evaluate the significance of relationships between the various variables under study.FindingsEmpirical findings showed that the PPM model with a second-order construct structure exhibited a better representation of the observed variables as compared to a first-order factor model. The results of the structural analysis indicated a significant direct relationship between withdrawal intention and each of the PPM model constructs: push and pull factors were found to have a positive impact on withdrawal intention, while mooring factors had a significant inverse relationship with withdrawal intention. The results of this study also revealed that the moderating role of the mooring construct was found in both relationships between push and withdrawal intention and between pull and withdrawal intention.Research limitations/implicationsThe absence of a longitudinal study measuring the actual withdrawal behavior is the main limitation of this study. Furthermore, withdrawal intention was examined without differentiating between individual and corporate depositors. Finally, despite being insightful, the empirical findings should be generalized with caution, as the sample was purposely chosen by the banks’ management.Practical implicationsThis study implied that participatory banks should stress the importance of mooring factors, as they strongly inhibit depositors’ intention to shift their funds to the conventional banking system. Moreover, this study provides great indications to Moroccan regulators and policymakers on a number of issues that can be used to develop policies that could improve the participatory banking system.Originality/valueTo the best of the authors’ knowledge, this study represents the first attempt to confirm the effectiveness of the PPM model in examining depositor-withdrawal intentions. This study is also the first of its kind to address profit-sharing investment depositors’ apprehensions in the Moroccan context, to the best of the authors’ knowledge.

Accounting Practices between Takaful Operators in Indonesia: A Comparative Analysis

This study aims to compare and analyze the difference between AAOIFI standards and PSAK 111. The method used in this study in content analysis. This study found that AAOIFI standards cover almost all of the areas covered under PSAK 111. However, AAOIFI standards are argued to be more holistic, focused and specific compared to PSAK 111. AAOIFI tends to encourage takaful operators to use wakalah model. Pro-forma Statement of policyholders’ surplus and deficit in FAS 12 only recognized the distribution of underwriting surplus to policyholders, while PSAK 111 recognized distribution both to policyholders and takaful operators. PSAK 111 recognized modified wakalah model for takaful operators. Consequently, Pro-forma Income statement in FAS 12 only recognized three sources of revenue of takaful operators. They are investment revenue (from shareholder’s equity), wakalah fee (ujrah) and profit-sharing investment (from policyholder’s fund), while PSAK 111 also included income from distribution of underwriting surplus. Keywords: Accounting Practices, Takaful Operators, AAOIFI, PSAK 111

Investasi Bagi Hasil di Bank Syariah: Perspektif Akuntansi

The purpose of this study was to examine the accounting treatment for mudharabah contracts and their implications for the reliability and fairness of financial statements based on an accounting perspective in Islamic banks. In addition, this study also explores the effect of provisions and reserves on profit allocation among profit-sharing investment account holders (mudharabah) and examines the accounting treatment for mudharabah contracts as stated in the Accounting Standards for Islamic Financial Institutions issued by AAOIFI. The findings of this study that presenting customers in a separate category in the statement of financial position (balance sheet), without reclassifying assets in the statement of financial position to reflect assets attributable to customers, indicates an undue bias in the financial statements. This goes against the concept of full disclosure and a true and fair view of financial statements. Other results also reveal that reserves can result in misallocation of profits among customers and there is an overlap between provisions and reserves, which can affect the reliability and fairness of financial statements. It is also revealed that the reserves presented under the customer section cannot be easily understood because investors do not have rights to these reserves. In addition, questioning the application of the use of grant contracts (Tabarru) in transactions with the substance seeking profit. This study recommends mutual funds as a solution for implementing sharia-compliant mudharabah contracts.

The effect of asset quality, profit and loss sharing on Sharia Banking Liquidity in Indonesia

This study aims to determine the effect of asset quality variables (Non-Performing Financing), Profit and Loss Sharing (profit-loss sharing investment and profit-sharing investment account), capital adequacy ratio, bank size, return on assets, and gross domestic product on Islamic banking liquidity in Indonesia. The analysis was conducted using a sample of 7 Islamic commercial banks from the period March 2015 to December 2019. This study uses 2 multiple regression models of panel data with the results showing that Non-Performing Financing, profit-loss sharing investment, bank size, gross domestic product affect the liquidity of Islamic banks. , then for-profit sharing investment account, capital adequacy ratio, return on assets, does not affect the liquidity of Islamic banks.

Predictive Factors of Withdrawal Behavior among Profit-Sharing Investment Depositors in Morocco: A Qualitative Study from the Perspective of Push-Pull-Mooring Framework

The main purpose of this study is to examine the determinants of deposit withdrawal behavior amongst profit-sharing deposit account holders. Based on the Push-Pull-Mooring theory, a qualitative study was conducted, with fifteen personal interviews undertaken with profit-sharing investment depositors selected from three participatory banks using a purposive sampling technique. Assessment of the predictive factors determining deposit withdrawal behavior resulted in three categories. The push factors were found to be, in order of decreasing frequency: (1) Sharia non-compliance risk, (2) lower rate of return, (3) deposit guarantee scheme and (4) customer relationship quality failure. The push factors were labeled as (a) conventional term deposit attractiveness, (b) conventional banks history and (c) number of branches. The mooring factors were found to be: (i) religiosity, (ii) switching costs, (iii) third-party influence and (iv) involuntary switching factors. This study has limitations that should be considered for future research. First and foremost, all interviewees were selected by the banks’ managers. Moreover, they were identified as individual depositors; thus, they displayed opinions, which may differ from those of corporate depositors. Despite the discussed limitations, the findings generated from this study have important implications for researchers, financial marketing managers as well as the policy makers and regulators. In terms of contribution to the body of knowledge, the study aimed to investigate the predictive factors of deposit withdrawal behavior in another context that of Morocco, which has not yet been explored in the literature. In addition, the findings of this study are critical to financial marketing managers for strategic marketing programs as it stresses the importance of satisfaction dimensions within a dual banking system, as is the case in Morocco. Furthermore, this study provides great indications to the policy makers and regulators on the perception of the Moroccan investment account depositors, in order to develop policies that could improve the participatory banking system in Morocco.

Does the deposit structure affect Islamic bank’s maturity transformation activities? The implications of IFSB liquidity guidelines

Purpose The purpose of this study is to investigate factors influencing the net stable funding ratio (NSFR) in the Islamic banking system. More specifically, the authors analyze the impact of the deposit structure on the liquidity ratio using the two-step generalized method of moments approach during the 2000–2014 period. Design/methodology/approach Based on IFSB-12 and the GN-6, the authors calculated the NSFR for 35 Islamic banks operating in the Middle East and North Africa (MENA) region. Findings The findings of this study show the following: first, ratio of profit-sharing investment accounts have a positive impact on the NSFR, while ratio of non profit-sharing investment accounts increase the maturity transformation risk; second, the results highlight that asset risk, bank capital and the business cycle have a positive impact on the liquidity ratio, while the returns on assets, bank size and market concentration have a negative impact; and third, these results support the IFSB’s efforts in developing guidelines for modifying the NSFR to enhance the liquidity risk management of institutions offering Islamic financial services. Research limitations/implications The most prominent limitation of this research is the availability of data. Practical implications These results will be useful for authorities and policy makers seeking to clarify the implications of adopting the liquidity requirement for banking behavior. Originality/value This study contributes to the knowledge in this area by improving our understanding of liquidity risk management during liquidity stress periods. It analyzes the modified NSFR that was adopted by the IFSB. Besides, this study fills a gap in the literature. Previous studies have used the conventional ratios to determinate the main factors of the maturity transformation risk in a full-fledged Islamic bank based on an early version of NSFR. Finally, most studies focus on the NSFR as proposed by the Basel Committee, whereas the authors investigate the case of the dual-banking system in the emerging economies of seven Arab countries in the MENA region.

The impact of profit-sharing investment accounts on shareholders’ wealth

This study evaluates the impact of profit-sharing investment accounts (PSIAs) on shareholders’ wealth. Using probabilistic tools, we derive an explicit formula for PSIA value. We apply this formula to calculate account values for a sample of 52 banks in 13 countries and determine an empirical rank order of value-drivers. We also assess the impact of returns’ smoothing schemes on shareholders’ wealth, namely the use of reserves and/or subsidies to adjust cash returns to investment account holders. We find that the value of PSIAs varies widely amongst banks, and that originating high-quality assets dominates returns’ smoothing in the value creation process. We also find that if subsidies are used without reserves to smooth returns, then shareholders’ wealth is destroyed in the long term for 77% of banks in our sample. This finding supports the practice of prioritising reserves over subsidies to smooth returns.

Profit- and loss-sharing impact on Islamic bank liquidity in GCC countries

Purpose The purpose of this paper is to empirically assess the impact of the principle of profit- and loss-sharing (PLS) on the exposure to liquidity risk of Islamic banks in Gulf Corporation Council (GCC) countries. The Islamic bank activity is distinguished by a PLS principle, which is likely to involve specificities in the bank liquidity issue. Design/methodology/approach This paper investigates the determinants of Islamic bank liquidity over the period 2005–2016 using a panel of 23 Islamic banks in GCC. The system of generalized method of moment estimators is applied. Findings The findings reveal that while profit-sharing investment accounts (PSIAs) are inversely proportional to Islamic bank liquidity, the PLS investment does not seem to act as a determinant of the bank liquidity. The fact that PSIAs are globally short-run accounts, but finance long-run projects leads to a substantial maturity mismatches, which limits the availability of liquidity buffer and exacerbates the bank’s exposure to liquidity risk. Moreover, capital adequacy ratio has significant and positive association with bank liquidity, as a strong capital ratio helps to strengthen the liquidity control. However, return on assets has a negative significant impact on bank liquidity. For instance, if the bank holds more cash, it deprives itself from placing funds and earning returns, which causes its profitability to decline. Practical implications This paper gives further insights to better improve the liquidity risk management in a context of scarcity of Shariah-compliant instruments. Islamic bank needs to determine the PLS purpose and goals to be consistent with the “bank’s financing policy” and convince its depositors to use their deposits for medium and long-run investments. Originality/value Unlike previous empirical research, this investigation tries to better grasp the Islamic bank liquidity issue by focusing on the PLS impact on liquidity risk. It aims to fill in the gap in the empirical literature on this topic.

Investment account holders’ market discipline in GCC countries

Purpose The purpose of this study is to investigate the two components of market discipline, investment account holder (IAH) monitoring and the consequent reaction of the Islamic banks in GCC countries for the 2004–2013 period, including the recent financial crisis of 2008. Design/methodology/approach We address the research question that Investment Account holders (IAH) in GCC countries suc as Kingdom of Saudi Arabia (KSA), Bahrain and United Arab Emirates (UAE) monitor their banks. Regression analysis was used to examine the dependence level of profit-sharing investment account (PSIA) growth rate on bank risk characteristics (CAMEL variables). Then, the reaction of banks by regression influencing CAMEL variables of one-lagged period on PSIA growth rate was verified. Findings The results provide evidence of the first component of market discipline, i.e. the IAH monitoring, in KSA, Bahrain and UAE. The common result to the three countries is that market actors are concerned with accounting information on capital adequacy. However, in UAE, they are also interested in assets performance, whereas they look more at earnings in Bahrain. The results show evidence of the second component in Bahrain; the bank reaction to IAH monitoring and subsequently IAH discipline in Bahrain. Finally, the results do not support any impact of the financial crisis. Research limitations/implications The sample size is small although it is constituted by banks having a sufficient number of observations. Practical implications This study highlights the importance of IAH discipline, which would help prudential bank monitoring by regulators and wealth development for both investors and managers. It should increase the disclosure of relevant information as for the part of effective accountability of Islamic banks’ governance. Originality/value This study contributes to the literature on market discipline by dealing with Islamic banks. It is one of the very few studies to investigate IAH discipline in Islamic banks and the second component of market discipline, i.e. the influence of monitoring on banks.

Is optimal Islamic financial contract stabilizing? The perspective of a New Keynesian model with the financial accelerator

This paper aims to inspect the stabilization aspects of Islamic financial contracts by drawing on a New Keynesian macroeconomic model with the financial accelerator. The model allows for shared responsibilities on both the assets and liabilities sides of the Islamic banks that resemble, in principle, the two-tiered Mudarabah financing on the asset side and profit-sharing investment accounts on the liability side. The implied optimal Islamic financial contract argues that payoff distribution between entrepreneur and bank is contingent on the macroeconomic environment via the entrepreneur's leverage, whereas that between bank and investors is endogenous to bank's capital and leverage. Compared to the conventional debt contract with a predetermined return, we find that an Islamic financial contract amplifies shocks as much as conventional financial contracts do, if not to a greater extent. The impacts on entrepreneurs' and banks' leverage, however, depend largely on the source of the shock and are opposite to those observed under conventional debt contract. Whereas favorable aggregate supply and monetary shocks increase the overall leverage, shocks favorably hitting preference and marginal efficiency of investment reduce the leverage. The underlying mechanism is the shock-shifting ex post payoff distribution between creditors and debtors that shapes the cost of the external finance and, thus, leverage.

Do Profit-sharing Investment Account Holders Provide Market Discipline in an Islamic Banking System?

Do Profit-sharing Investment Account Holders Provide Market Discipline in an Islamic Banking System?

Implications of Profit Sharing Investment Accounts on the Capital Structure of Islamic Bank: A Comparative Study

Islamic banks are different from conventional banks both in terms of their assets and liabilities. One of the major difference in conventional and Islamic banks is the presence of profit sharing investment (PSI) accounts, a quasi-equity, and a buff to bear the financial risk of Islamic banks before it hits the depositors. This paper compares the impact of deposits on the market value, earnings per share (EPS) and financial risk of shareholders of Islamic and conventional banks in Pakistan. The empirical evidence suggests that deposits have a negative impact on market value and EPS of conventional banks. While in the case of Islamic banks, we do not find any significant impact of PSI accounts on market value of Islamic banks; however, we do find the evidence of the significant positive relationship of PSI accounts with EPS. Contrary to the general belief, we find evidence that higher growth in PSI accounts leads to elevated financial risk. The higher financial risk can be attributed to the income smoothing practices of Islamic banks where Islamic banks announce the profit rates of PSI accounts similar to deposit rates offered by their conventional counterparts.

Classification of profit-sharing investment accounts

PurposeThe purpose of this paper is to examine the classification of profit-sharing investment accounts (PSIAs) under various accounting standards, and determine whether Islamic banks maintain uniform practices when the same accounting standards are applied. It also aims to determine whether Islamic banks consider investment account holders (IAHs) important financial statement users by disclosing necessary information pertaining to PSIAs.Design/methodology/approachA sample composed of financial statements from 63 Islamic banks from 15 countries is compared with respect to the information related to PSIAs.FindingsThe results show heterogeneity of classification for PSIAs. Applying the same standards does not lead to the uniform classification of PSIAs when banks apply International Financial Reporting Standards, while financial statements applying Financial Accounting Standards by the Accounting and Auditing Organization for Islamic Financial Institutions are more similar. The perplexity in classifying PSIAs brings obscurity on the treatment for PSIA-related accounts, particularly returns attributable to IAHs. The fact of fewer disclosures pertaining to PSIAs in Islamic banks – which apply accounting standards not specifically tailored to Islamic finance – suggests that IAHs receive less attention under those accounting standards.Research limitations/implicationsThe main limitation relates to the lack of financial statements available online and the possibility of sample selection bias toward larger Islamic banks.Originality/valueThis research contributes to the limited literature on accounting for PSIAs, and reveals the diversity of reporting methods for unique transactions in Islamic banks and the insufficiency of current accounting standards to guide them, which create possible challenges of comparability.

Profit-sharing investment accounts in islamic banks or mutualization, accounting perspective

PurposeIslamic banks use Mudarabah contract to replace the interest-bearing deposits with profit-sharing investment accounts. The purpose of this paper is to explore the challenges and problems associated with the employment of Mudarabah contract by Islamic banks.Design/methodology/approachThe study critically analyzes the Mudarabah contract used by Islamic banks. It reviews the evolution of the contract from its traditional type to more complicated types such as compound, unrestricted, commingled and continuous Mudarabah. The paper investigates the problems that have emerged from implementing such types in current business settings.FindingsThe paper proves that implementing the Mudarabah contract by banks imposes several problems among which are the following: difficulty in the determination of total profit resulting from Mudarabah and in allocating this profit to the multiple parties involved in Mudarabah; usage of reserves to cater against future losses may undermine the concept of Mudarabah profit-loss sharing and lead to earnings management; corporate governance is also a major problem in Mudarabah contract, as the depositors are exposed to risks but have no governance rights; and Mudarabah may also lessen the fair presentation of financial reporting.Research limitations/implicationsThe paper examines the evolving Mudarabah contract and its implementation challenges, based on available literature (no empirical analysis was conducted).Practical implicationsThe implications are significant for the future development of Islamic contracts and Islamic accounting treatments.Originality/valueMany studies explored the Mudarabah contract from a Shariah or law perspective. However, this paper investigates the Mudarabah contract with a focus on the implication on accounting and financial reporting because of the lack of studies in this area. Furthermore, it demonstrates the persistent flaws in the Mudarabah contract, and it proposes a new model for mobilizing funds, i.e. mutual fund.

Solvency stress testing of Islamic commercial banks

Purpose This paper aims to provide a methodology for designing and conducting solvency stress tests, under the standardised approach as per IFSB-15, including the establishment of macro-financial links, running scenarios with variation of assumptions and stress scenario parameters; apply and illustrate this methodology by providing a stylised numerical example through a tractable Excel-based framework, through which Islamic Commercial Banks (ICBs) can introduce additional regulatory requirements and show that they would remain in compliance with all capital requirements after a moderate to severe shock; and identify the potential remedial actions that can be envisaged by an ICB. Design/methodology/approach The paper uses the data of the one of the groups to which certain amendments and related assumptions are applied to develop a stylised numerical example for solvency stress-testing purposes. The example uses a Stress Testing Matrix (STeM; a step-by-step approach) to illustrate the stress-testing process. The methodology of the paper uses a two-stage process. The first stage consists of calculating the capital adequacy ratio (CAR) of the ICB using the IFSB formulae, depending on how the profit sharing investment account (PSIA) are treated in the respective jurisdiction. The second stage is the application of the stress scenarios and shocks. Findings Taking into account the specificities of ICBs such as their use of PSIA, the results highlighted the sensitivity of the CAR of an ICB with respect to the changes in the values of alpha and the proportion of unrestricted PSIA on the funding side. The simulation also indicated that an ICB operating above the minimum CAR could be vulnerable to shocks of various degrees of gravity, thus bringing the CAR below the minimum regulatory requirement and necessitating appropriate remedial actions. Practical implications The paper highlights various implications and relationships arising out of stress testing for ICBs, including the vulnerability of an ICB under defined scenarios, demanding appropriate immediate remedial actions on future capital resources and capital needs. The findings of the paper provide a preliminary discussion on developing a comprehensive toolkit for the ICBs similar to what is developed by the International Monetary Fund Financial Sector Assessment Programme. Originality/value This paper focuses on the gap with respect to the stress testing of capital adequacy. The main contribution of the paper is twofold. The first is the development of an STeM – a step-by-step approach, which provides a method for simulating solvency (i.e. capital adequacy) stress tests for ICBs; the second is the demonstration of the potentially crucial impact of profit-sharing investment accounts and the way they are managed by ICBs (notably the smoothing of profit payouts) in assessing the capital adequacy of the ICBs.